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Column Corner: Back to the FoldCWS 30 July 2.14

CWS 30
 Faced with the ever-growing need for workforce flexibility and just-in-time delivery of worker skill sets, employers have increasingly been moving parts of their traditional employee workforce into a contingent workforce. Many retirees, down-sized employees, and people who just want freedom and flexibility are increasingly opting to work as contingents, even for the companies that most recently employed them. If done correctly, these “alumniâ€? worker arrangements can benefit both the employer and the individual. To realize all potential benefits of this transition, employers must ensure that they continue to comply with applicable employment, labor, and tax laws, and that they properly classify their workforce. This article outlines the issues that employers should consider when transitioning to a contingent workforce

Change in Liabilities In many cases, employment, labor, and tax laws apply differently to employees, contingent employees, and independent contractors. Accordingly, employers that are transitioning former employees into contingent workers should consider the changes in laws that will affect their new workforce. To ensure legal compliance, we discuss select laws that apply to these workers, as well as the steps employers should take as they transition employees contingent status.

Consolidated Omnibus Budget Reconciliation Act (COBRA). COBRA requires continuation of group health plan coverage for employees who would otherwise lose coverage because of certain events, such as termination or a reduction in hours. The Act applies to all employer group health plans, other than those provided by employers with fewer than 20 employees. All workers covered under the employer's group health plan are covered by this Act. Therefore, employers must carefully review their group health plans to ensure that these plans include only those workers who they intend to cover.

Employee Retirement Income Security Act (ERISA). ERISA establishes uniform standards for employee pension and welfare benefits plans. ERISA does not require employers to provide pension or welfare benefits to employees, but it regulates the voluntary plans of all employers engaged in commerce or industry affecting commerce. The employer's benefits plan (not the contract with the worker or the contract with any third party agency) determines whether the worker will be eligible for benefits. Therefore, contingent workers are covered by ERISA only if the employer's benefit plan allows them to participate in the plan; and they are excluded from the plan only if the plan excludes them. Employers should carefully review their benefits plans to ensure they know exactly whom the plan covers, and specifically to ensure that it does not cover those whom the employers intend to exclude.

Further, employers must properly apply the terms of the plan, or contingent workers whom the employers intended to exclude might in fact be considered covered under the plan, and, therefore, under ERISA. Finally, the plan should include proper language providing the plan administrator with the necessary authority to interpret and apply the plan's provisions. This language should ensure that the plan administrator's interpretations and actions are granted the deferential "arbitrary and capricious" standard of review. Regular, scheduled plan review with qualified counsel is the best defense against unplanned coverage for alumni or other contingent workers. Equally important is that counsel fully understand what the workers in questions actually do, and their relationship with the company; titles, contracts and labels are not the most important things -- the actual relationship is what drives coverage.

When transitioning alumni into contingent workers, employers must account for potential liabilities under ERISA, which makes it unlawful for an employer to "discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary [of an employee benefit plan] ... for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan." Fundamental business decisions, such as reducing overall costs, can be a legitimate reason to eliminate certain benefits. However, an employer that is considering transitioning from an employee workforce to a contingent workforce should ensure, at the very least, that reducing benefits costs is not the sole motivating factor in its decision to outsource certain operations. The employer should be prepared to provide documentation of its legitimate reasons for this decision.

Health Insurance Portability and Accountability Act (HIPAA). HIPAA limits, and in many cases entirely eliminates, the amount of time that beneficiaries must wait for an employer's group health plan to cover a pre-existing condition, as well as the amount of time for a plan to cover beneficiaries who change employers or move from employment to unemployment. HIPAA does not require employers to provide health insurance to its employees, nor does it require employers that do offer health insurance to cover part-time, seasonal, or temporary employees. Therefore, employers should review their group health plans to ensure that these plans include only those workers whom they intend to cover. If there are alumni or other contingent workers at issue, plan review should include a thorough understanding of the relationships of such workers to the company.

Fair Labor Standards Act (FLSA). The FLSA establishes minimum wage, overtime, and child labor standards for employees. The FLSA covers all employees engaged in commerce or the production of goods for commerce; all domestic service employees; all employees of hospitals, residential care institutions and schools; and all local, state, and federal government employees. Under its broad reach, the FLSA covers contingent workers, except independent contractors and self-employed workers. The FLSA does not distinguish between full-time and part-time employment or between temporary and permanent workers. According to Department of Labor (DOL) regulations, in joint-employment relationships (where more than one employer has legal responsibility for the worker, and the employment among the employers is related), all employers are responsible for complying with the FLSA. Therefore, joint employers should address in writing which entity is responsible for complying with the FLSA. While aggrieved employees will still be able to sue either of the joint employers for noncompliance under the FLSA, clear contractual language might help to minimize the litigation expense of sorting out liability.

A trap with regard to engaging higher-level alumni and other contingent workers has to do with exempt status. Many workers consider it prestigious to be "exempt" from overtime, or consider it to be demeaning to be paid hourly and receive overtime. Employers must resist the temptation to give in to these sentiments. Employees should be classified correctly, even if they don't like the classification.

Family and Medical Leave Act (FMLA). The FMLA provides various protections for employees who need time off of work because of family medical issues or the birth or adoption of a child. To qualify for coverage under the FMLA, the employee must have worked for the employer for 1,250 or more hours during the past 12 months. The FMLA applies to employers that employ 50 or more employees who work 20 or more calendar weeks in a year. Independent contractors and self-employed workers are not counted as employees for determining whether the employer has 50 or more employees.

According to DOL regulations, under a joint-employment relationship, only the primary employer is responsible for complying with the FMLA notice requirements. However, both employers are barred from interfering with FMLA rights, and in many cases both employers have duties with respect to returning an employee to work. Accordingly, joint employers must determine which entity is the primary employer of their contingent workforce, and must cooperate in return to work situations.

Federal non-discrimination laws. Title VII of the Civil Rights Act ("Title VII"), the Americans with Disabilities Act, (ADA) and the Age Discrimination in Employment Act (ADEA) are some of the federal laws that protect job applicants and employees from various forms of discrimination, such as that based on race, national origin, gender, disability, and age. Title VII and the ADA apply to employers that have 15 or more employees for 20 or more calendar weeks in a year. The ADEA applies to employers that have 20 or more employees for each working day in 20 or more calendar weeks in a year. Each state (and in some cases, municipalities) has parallel laws, which in many cases provide more protection to employees and are more restrictive on employers.

Title VII, the ADA, and the ADEA cover contingent workers other than independent contractors. In fact, each of these Acts explicitly includes temporary employment agencies and their employees in its coverage. To reduce risk of liability, joint employers should ensure that each others' non-discrimination policies and procedures comply with Title VII, the ADA, and the ADEA.

While independent contractors are generally not covered by these Acts, another provision of the Civil Rights Act provides protection of independent contractors from racial discrimination in both the terms of a contract and in the creation of a hostile work environment. Businesses must be careful not to relax their vigilance against discrimination in cases in which alumni are determined to be independent contractors, because businesses face liability for most types of discrimination whether a person is correctly classified as an employee or as an independent contractor. In short, businesses should avoid discrimination, regardless of whether the people being discriminated against are their employees, joint employees, somebody else's employees or independent contractors. In almost all cases, there is a lawsuit there, regardless of the answer to the employment classification question.

National Labor Relations Act (NLRA). The NLRA guarantees the right of employees to organize and bargain collectively. The NLRA applies to all employees and employers in their relationships with labor organizations whose activities affect interstate commerce, regardless of the size of the employer or labor organization. Under current National Labor Relations Board precedent, contingent employees normally cannot be included in the same bargaining units as other employees without employer consent. It is widely expected that this precedent is about to change, and mixed bargaining units containing contingent and other workers are likely to become fair game, or much easier to form. In any case, employers should monitor developments in this area over the coming months.

Employers should monitor workplace sentiment among contingent employees, particularly among the employer's alumni, to prevent unions from taking advantage of workplace discontent. After all, employers are likely to lose much of the incentive of transitioning to a contingent workforce if they are faced with the logistical and monetary burdens of responding to bargaining unit campaigns related to contingent employee complaints.

The NLRA does not cover independent contractors. In the last few years, national litigation over the proper classification of independent contractors has included NLRB litigation; and this is expected to continue. Unions are typically suspicious of and hostile to any independent contractor classification. Businesses should expect continued scrutiny of independent contractor classification decisions under the NLRA.

Occupational Safety and Health Act (OSHA). The OHSA requires employers to maintain certain safety and health standards for their employees and contingents. OSHA responsibility goes far beyond "co-employment" or even "employment." Businesses have workplace safety duties regardless of whether the person injured is their employee, a co-employee, or an independent contractor. The general rule is that, where more than one employer works on a worksite, the employers of employees exposed to safety and health hazards, known as "exposing employers," are liable for citation by OSHA. Other employers, however, are also subject to citation by OSHA, regardless of whether their own employees were exposed:

  1. The employer that actually created the hazard (known as the "creating employer");

  2. The employer that was responsible, by contract or by actual practice, for safety and health conditions on the worksite; that is, the employer that had authority for ensuring that the hazardous condition is corrected (known as the "controlling employer"); and

  3. The employer that had the responsibility for actually correcting the hazard (known as the "correcting employer").

Businesses need to be aware of their workplace safety duties, which in most cases are the same for alumni as for regular employees, regardless of how alumni are classified.

Unemployment compensation. The unemployment compensation system pays benefits to workers who become unemployed and meet state-established eligibility rules. In most states, only employees and contingent employees are eligible to receive unemployment benefits; independent contractors and self-employed workers are ineligible.

Most states use a unique test to determine whether an individual is an "employee" under the unemployment compensation system. Under this test, workers are considered employees unless (1) they are free from direction and control over performance of their work; (2) their service is performed outside the course of business for which it is usually performed or their service is performed outside all places of business of the enterprise for which it is performed; and (3) the individual is customarily engaged in an independent trade, occupation, profession, or business. Employers should closely review their state laws to determine whether their contingent workers would be eligible for unemployment compensation in the event they became unemployed.

Worker Adjustment and Retraining Notification Act (WARN). WARN requires employers to provide employees notice 60 days in advance of covered plant closings and mass layoffs. In general, WARN applies to employers with 100 or more employees, including contingents. Employees who have worked less than 6 months in the last 12 months, and employees who work an average of less than 20 hours per week, are due the same notice as full-time employees. However, these part-time employees are not counted when determining whether the employer employs 100 or more employees. Independent contractors are not due notice under WARN. When considering plant closings and mass layoffs, employers should be sure to provide comprehensive notice to all employees and contingent employees.

Workers' compensation. State and federal workers' compensation programs provide benefits for wage loss and medical care to workers who sustain work-related injuries. Independent contractors and self-employed individuals are generally not covered under workers' compensation programs, though contingent employees might be eligible for these benefits under applicable state laws.

When transitioning an individual from an employee to independent contractor or other contingent status, employers should be aware of the potential loss of the workers' compensation safety net. Workers' compensation programs provide employers with limited and determined liability in exchange for no-fault compensation benefits for the employee. This concept is called "exclusivity." Where employers face workers' compensation liability, with some exceptions this is their only liability -- they cannot also be sued. In most states and in most cases, companies and their contingent labor suppliers both enjoy exclusivity protection, but this is subject to state law, which varies greatly.

True independent contractors or other non-employees, meanwhile, because they are not covered by workers' compensation programs, maintain the common law right to sue companies for damages associated with work-related injuries. While liability is often difficult to prove in common law civil cases, employers caught in a civil case risk much higher payouts and litigation expenses than they would have to endure under workers' compensation programs.

Businesses re-engaging alumni should carefully review their insurance policies and consult with their brokers/insurers to ensure that they have proper insurance in place which provides coverage for alumni and other contingent workers, regardless of whether the workers are later re-classified as employees, co-employees, or independent contractors.

Avoiding Misclassification.

Misclassification of workers as employees of some other entity (and not as co-employees of two or more entities), can create significant risk. Even greater risk is created by misclassification of workers as independent contractors. Because there exists no single standard by which federal and state courts and agencies determine independent contractor status, many employers struggle to determine how best to ensure their alumni meet the level of independence and entrepreneurship that federal and state laws require of independent contractors.

The law, not the employment contract, determines whether an individual is working as an employee or an independent contractor. Employers should take care to properly classify all putative independent contractors. The IRS and other agencies are likely to scrutinize any "employee" immediately returning as an independent contractor, if that person is doing the same job they did before; especially if the person has no business expenses; and even more especially if they do not have any other clients, and aren't looking for any. Whatever procedures are in place for ensuring proper independent contractor classification, businesses should exercise greater caution in classification of alumni, and in most cases should avoid immediately rehiring alumni as independent contractors.

Tax Considerations

Some employers mandate a break in service between an individual's "employee" and "independent contractor" status in order to avoid raising a red flag with the Internal Revenue Service and state tax agencies. Perhaps the most effective way to avoid this red flag is to refrain from hiring an alumnus back as an independent contractor within the same tax year. While filing both Forms W-2 and 1099 for the same social security number in the same tax year is not illegal, it is possible that doing so could trigger a federal or state tax audit. The IRS can be expected to suspect that the employer may have reclassified the individual as an independent contractor simply to avoid "employee" tax requirements.

The IRS estimates that it loses billions of dollars in tax revenue each year due to the misclassification of employees as independent contractors. As the "Baby Boomer" generation enters retirement age, the number of workers claiming to be independent contractors is likely to increase. Although eligible for retirement, economic conditions will prevent many of these workers from leaving the workforce altogether. Looking for more flexibility and independence, many of these workers seek nontraditional employment arrangements. Anticipating this change in the dynamics of employment relationships and its potential adverse affects on tax revenue, the IRS has resolved to crack down on the problem of independent contractor misclassification.

The IRS and state tax agencies can and do fine employers for uncollected payroll taxes on employees misclassified as independent contractors, even if the misclassified workers have paid their taxes in full. Because of greater scrutiny of the independent contractor classification, employers must take special care to properly identify and classify their contingent workforce.

Penalties for Misclassification

Tax penalties for worker misclassification are significant. But the IRS and state tax agencies are not the only government institutions concerned with worker misclassification. Indeed, IRS investigations into a worker's proper status often result from non-tax employment matters involving the Department of Labor, the Equal Employment Opportunity Commission, state unemployment or workers' compensation agencies, and even the Department of Homeland Security. Where such employment matters result in legal disputes over a worker's proper status, employer penalties could be significant.

To illustrate, in 2001, Microsoft reportedly settled a contingent worker case for $97 million after the Ninth Circuit Court of Appeals agreed with the plaintiffs that the company had mislabeled them as independent contractors. The court found that the plaintiffs were in fact employees and should have been allowed to participate in Microsoft's benefits plans, including its stock option plan.

Penalties for employers that are found to have misclassified employees as independent contractors could extend even beyond civil court. Several states have recently passed legislation aimed at bringing attention to the problem of worker misclassification. In Delaware, for example, new legislation provides for criminal fines and imprisonment penalties for employers, whether the employer misclassified the worker knowingly or unwittingly. Further, if an employer is found to have knowingly misclassified a worker, Delaware may bar the employer from working on public projects. Other states have similar laws; and more are coming.


The "legal tail" need not "wag the dog." If a contingent relationship between a former employee and a business makes sense and is mutually advantageous, it should happen. The benefits associated with transitioning an employee into a contingent worker alumnus are real. The risks are also real -- especially in alumni situations; but through understanding and managing those risks, businesses and their staff can realize their goals.

Eric H. Rumbaugh and Charlie Stevens are partners Kelly Rourke is an associate with the law firm of Michael Best & Friedrich LLP, headquartered in Milwaukee ( They represent employers in labor, employment and employee benefits law matters.


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